Should you always hedge a trade? Why not just trade a smaller amount?
I am trying to start trading in a PA mostly to gain a feel for it and I think I’ll learn more with a bit of my money on the line. I have two scenarios I’ve been thinking about:
If you take a long position in a stock, is it consensus to always hedge it? With put options for example. Why not just trade a smaller quantity of shares rather than hedge it with options?
If you take a short position, I’m sure it’s definitely standard practice to buy call options since the downside risk of the short is unlimited, right?
I’m just trying to confirm whether it’s consensus to always hedge long or short trades in the HF space but also for personal trading. Thanks
Based on the most helpful WSO content, here are some insights on hedging trades:
Hedging Long Positions
Hedging with Put Options:
Trading Smaller Quantities:
Hedging Short Positions
General Considerations
Practical Advice
In summary, while hedging can provide significant protection, it comes with costs and complexities. For personal trading, especially when starting out, trading smaller quantities might be a simpler and more cost-effective approach.
Sources: How to hedge a call option, Trading Ideas: Matter of Edge, https://www.wallstreetoasis.com/forum/trading/converts-trading?customgpt=1, https://www.wallstreetoasis.com/forum/trading/what-is-a-traders-objective-and-how-can-they-justify-not-speculating?customgpt=1, Why don’t hedge funds liquidate their positions in a recession?
It depends on your strategy and what you’re trying to bet on. If you think NVDA will outperform the Nasdaq and have a high conviction on this belief but worry that there is a medium to short term risk the US goes into recession which could cause both Nasdaq and NVDA to sell off 20% then you would want to buy NVDA vs selling NQ as your hedge. You can do this bet with massive size, and you’re hedged against broader macro moves.
Whereas if you’re a retail person you might be fine buying NVDA and holding it with no concern from a short term 20% drawdown because your outlook is 3 years from now with a price target 100% higher than the current stock price.
It’s just a different strategy to be long only versus hedged. Hedging versus no hedging ultimately depends on how you’re modeling and how you’re betting.
Trading in your PA is a bit different than on the job - its good that you are trying to replicate some things here, but practically I'm not sure it works out in your favor either way (both in terms of returns and as a teaching experience).
The goal of your PA is to maximize long term absolute returns - hedging will be counter to this goal (and you are not delivering a product to an LP with certain risk characteristics so its a doubly moot point). Sometimes it can be appropriate to take an overall portfolio hedge if you are on the more active side of your PA obviously, but usually will be to the detriment of your goals. In terms of it being a teaching experience, you will still gain valuable reps putting real money on the line on the LO side, and having that feedback system of the market change and testing your conviction levels, seeing how the narrative of a stock/business flows through multiple earnings, etc. I think that should be sufficient for learning. Same for being more active if you want to short (which again can be less pratical for a PA). When it comes to actually hedging your PA for your individual positions, not sure there is a good enough reason to do so ever. Maybe others have different thoughts.
On the job, assuming a pod shop, hedging will be there to eliminate any factor and market risk, with the goal of ending up with a positive long/short spread, so lets say +3% (long was up 6%, and short was up 3%); this would be fantastic at a pod shop if you levered it up, but maybe less so for your PA. Also have more active alpha shorts obviously, etc.... point still being, I think you'll gain the experience you want anyways by just investing LO with a longer term mindset as most others do in their PA.
Thanks so much for all the advice. What about if I’m doing special sits? For instance if there’s an equity overhang on a company and after doing research I have conviction there’ll be a positive catalyst that sends the price back up. So I take a big position.
In this case I’d still want to hedge just in case smth happens. So would it be reasonable to hedge with put options of the same stock?
Also I am definitely interested in trying to find good short ideas. But as the downside risk is unlimited I’ll definitely try to hedge it
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